KLA Corporation (KLAC) Earnings Call Transcript & Summary

Good morning, and welcome to the third day of JPMorgan's 51st Annual Technology Media and Communications Conference. My name is Harlan Sur, semiconductor and -- semiconductor capital equipment analyst for the firm. Very pleased to have Bren Higgins, Executive Vice President and Chief Financial Officer of KLA here with us today. I've asked Bren to start off with some opening remarks, then we can go ahead and kick off the Q&A. So Bren, thank you very much for joining us this morning, and let me go ahead and turn it over to you.

Yes, Harlan, thank you for having us. Just quickly, and I'm sure we'll talk a lot about the current environment, I just want to spend just a minute and do a little retrospective on '22. Company did about $10.5 billion in revenue in '22, which was a growth rate in the high 20th percentile. We also drove earnings to grow in the high 30th percentile. So it was a really strong year for the company overall. Our semi PC, which is the semiconductor process control part of the company, the systems business was up about 36% in the year against the WFE backdrop that was in the high single digits. So really strong performance overall. Reflecting the strength of the mix in the logic foundry environment for the company are increasing relevance around certain key products, which I'm sure we'll talk about as we move forward. And some -- what was recently published, some strong market share performance, where the Gartner organization just published its market share report for the year, and we saw about 3 points of share gain overall for the company. So really pleased with that performance. Our service business, which really stands out when you go into a slower environment, when things are ramping, I think everybody tends to focus a lot on systems. But when things slow down a little bit, the resiliency of service becomes a bigger issue. Our service business last year was up almost 15%. As we look at this year, it should be a growth year for that business and comes at accretive operating margins, which is also a strong attribute of the business. Our EPC business, which is our more than more part of KLA, which is electronics, packaging and components business, was -- is closer to consumers, and so that business was not as strong as the semi front end, but still had a good year with high single-digit systems growth. As we look at 2023, we characterize the industry environment of down about 20% from a $95 billion WFE number from '22, with memory being down considerably somewhere in that 40% range or so. Flash, down, worse than DRAM overall. On the logic foundry side, leading edge, some slowdowns and adjustments to capacity planning at the leading edge after what was 3 years of pretty strong growth. In fact, WFE was up about 22% from '19 to '22. So we knew there'd be a digestion or correction out there at some point. Certainly, we got here faster than what we expected. So we're carrying a little bit of overcapacity related to what we were expecting to do and versus where we are today. But still, the leading edge, down more. But the -- or the legacy part of the business, which we define as 28-nanometer and below, continues to be strong, and I think that part of logic/foundry is likely to be up this year. So we also have exposure, 2 parts of the market of WFE: the reticle inspection, where there's reticle capacity that's being added; but also silicon wafer capacity. And so those are parts of the market that are driving some growth for the company this year despite WFE being down. Service, our service business isn't going to grow 12% to 14%, which is a long-term target this year, but should grow somewhere in the mid- to high single digits. So we feel pretty good about that. Obviously, utilization rates on the installed capacity out there have slowed a bit, obviously, mostly in the memory space. And so that does put some pressure on service growth, but service will continue to grow. 75% of the revenue in our service business is contract-based. So it provides a predictable stream that we can rely on, but we can also optimize on from an efficiency point of view. So we're happy we have that, and I think it's a good anchor for the company. It's only been down 1 year in the last couple of decades. And so I think the KLA service business, which is really about services and break-fix support, not equipment and tools, is unique in the industry, given the nature of process control and the nature of how customers buy our products, the nature of the complexity of our products. And so that tends to be a good driver for us in any industry environment. And then the EPC business still is struggling a bit in terms of the exposure to some of these consumer markets, which continue to be weaker. So the PCB part of the business, the components inspection flat panel, is experiencing those dynamics. Although the specialty semiconductor, given the growth of compound semi and power in the automotive market, is -- looks to have a year that likely would be flat to perhaps up a little bit this year. So some pockets of strength in there in a down year. I think as we look at the relative performance, KLA saw a nice step-up in relative performance. Our share of WFE grew from the low 6s to the high 7s from '21 to '22. I think as we look at '22 into '23, I feel very good about the sustainability of that share of market and our ability to continue to outperform. So a lot of good drivers that are driving more investment in process control across all segments. And maybe I'll just stop there, and we'll go on with the questions.

That was a great overview. Thank you. If we -- you gave us a nice snapshot of the very sort of near to midterm. If we step back and look back over the last 10 years, right, 4 semiconductor down cycles, including this down cycle. Wafer equipment spending has grown at an 11% CAGR versus the semiconductor industry growth at 6%. KLA has grown its revenues at a 12% to 13% CAGR over that period of time. So clear outperformance given the complexity challenges, more focused on yield and cost, the needs for more installed capacity to support strong demand trends. Do you anticipate WFE to continue to outperform overall semiconductor industry dynamics? And then with that, given what you're seeing being the leader in the market, do you continue to see process control outperforming WFE as well? And what are going to be some of the major drivers?

So when you look back over that time frame you talked about, there was a period of time where there was virtually no incremental logic/foundry investment, right? In fact, logic/foundry, WFE from calendar '12 to '18, 2012 to 2018, was negative 3% or 4%. So there was a period of time due to the delays in the introduction of EUV, the lack of scaling in the industry, the lack of new designs at the leading edge that drove a fairly limited sort of growth environment from a logic/foundry point of view. And certainly, as we moved into the 2019 time frame, we saw that start to change. You saw a lot of design start to emerge at the 7-nanometer node. You saw the introduction of EUV, which started to add a technical driver to how our customers were managing their -- the ramping of their facilities and production yield, but also compelling attributes to the node that drove a much more robust design environment. And so that's important because our customers are managing against a lot of designs that they have to deliver in tight windows. They don't want to start too many wafers. They don't want to start too few. They have that dynamic that they're managing, but also they've got the pressure of a lot of different process flows and trying to manage through all that, that test design rules in different ways. So all that's been very good for process control, and we saw a step-up in the share of logic/foundry as a percent of overall WFE from somewhere around 45%, 50%, top around 60% plus. And so we're living in that environment today. Also, as you start to have all that capacity tied to those designs, as you start to ramp the next node, the ability to take that capacity and try to migrate it and try to reuse it where our customers can and given how much they invest, they all try to do that all the time, the opportunities to do that were fairly limited: a, because the capacity was being consumed; but also b, because the technical drivers were starting to change. And so it forced a whole new investment cycle as you moved into the 5-nanometer node and so on. So that was really good for process control. And so we expect as we move forward, a lot of the dynamics are going to continue. Capital intensity has went down for a long period of time. And you go back about 8 or 10 years, and it sort of stopped, and it's been slowly rising. Our view is that semiconductor revenue is going to continue to grow. Semiconductor -- this view of $1 trillion out there in 2030, that's been exposed by a number of folks. We think that's a reasonable way to think about it, a 6% to 7% type growth rate from 2021. We think because of capital intensity that WFE will likely grow a little bit faster than that. Because of the mix of business, the importance of process control, we'll see process control grow a little bit faster than that overall. And that KLA, given the products we're exposed to, where we have very strong share, which are inflecting in this environment, and we expect to grow moving forward, plus new offerings that are coming down the pipe that we think that KLA is in a position to grow faster than that. So when you back it up and you say, okay, what's the long-term view, we think as we outlined at our Investor Day that we'll grow revenue 9% to 11%. And with the operating model of the company, we should be able to grow the earnings of the company somewhere around 1.5x the revenue growth rate. So yes, I feel pretty good about our ability to sustain it. And we -- as we thought about the '26 plan, we knew there'd be a correction out there, as I said earlier. And so we kind of built that into our model, and our view currently is unchanged from what we laid out a year ago.

So if we look at this year, we estimate that your process control franchise will outperform WFE again this year, down about 12% to 15% versus WFE at down 20%, 20% plus. We know that your growth outperformance has been a combination of share gains and overall increasing process control intensity, as you just talked about. This year's demand profile, though, is a bit more different, right? We've got more contribution from mature technology, which tends to have lower process control intensity. But that being said, your memory segment, which also has lower process control intensity is down quite a bit, right? So there's some puts and takes here. But obviously, continued strength in leading-edge, relative strength in leading-edge advanced foundry and logic. But given your visibility, is overall process control intensity continuing to trend higher this year? And is part of the outperformance continued share gains as well?

Yes. I think it's a combination of the 2, and I've been pretty adamant over the last 6 months about despite the maybe carryforward of some of the capacity or some of the shipments that happened at the end of '22 or happened in '22 that would start to show up in '23 that because we were able to outperform by as much last year that somehow there'd be a retrenching this year. It's pretty clear in my view that when we looked at '23 that given customers continue to invest in road maps irrespective of what's happening from a demand point of view in both segments, and that tends to be good for KLA, is we really provide information that speeds time to results, to speed the time to ramp. It's not quality control. It's really -- it's more about providing information to improve learning cycles as customers ramp a process node. So they're going to continue to do that, and so we feel pretty good about that. That memory was cycling more. And so to your point, process control intensity is higher overall in logic and foundry. And so the market moves in our direction. I think that's a good thing. We have particular products that are inflecting with EUV, and we would expect -- we're still short supply in those cases. And so those products, I would expect to grow this year. I thought that would be positive. There'd be infrastructure investment in China, but even in silicon wafer investment overall that, in some ways, it's a little -- I wouldn't call it countercyclical, but carries a different cycle. And so that's part of WFE that we're exposed to that others aren't, and we have a very strong share there. So -- and I think the effects of the export controls that were out there, also that the amount -- the percent of the business -- semi equipment business for KLA versus some of the peers was a little bit less in terms of where the export controls were falling. So when I looked at all of it, I felt like, hey, despite the fact there might be some of this carryforward revenue, I felt pretty good about our ability to maintain our share of overall WFE and relative performance. And it was an important message for us at earnings that against this backdrop of WFE down somewhere around 20% that we think we're lining up somewhere in the mid-teens in terms of the relative performance. So I think there's sustainability because of some of the issues we talked about and feel pretty good about where we're at.

Your lead times for your tools are quite long, right? They're very complex relative to, let's say, some of your peers out there. Optics, light sources, advanced chamber designs, pretty significant software compute and analytical capabilities embedded in your systems as well. Some of your tools, I believe, like reticle and wafer inspection have like 9- to 12-month lead times, and demand continues to outstrip supply rate. So given all of this and some pretty significant next-generation process inflections like move to gate all around, backside power distribution, you do have some insights into your customer spending trends next year, technology migration plans. I mean what's your sense directionally, qualitatively about the setup for 2024?

The '24 question? I knew it was coming at some point. Look, I think as we go through this correction year and, certainly, there's a macro overhang that's going to affect how the industry recovers, the industry is digesting capacity and then what will demand drivers look like as we move into '24. Our view right now is we believe and we've made decisions in terms of how we're sizing the company with an expectation that we'll see a resumption in demand, sequential demand at some point in '24. It's not clear exactly when, but we're certainly sizing and running the company with that expectation and believe that, given what I said earlier about our views of our '26 plan, that we need to make sure we're investing in the right products to be able to enable that and that we have the capacity in place to be able to support it. So look, I think if you look at the different segments, we're obviously benefiting a lot from some of the legacy investment. Some of that is in China. I think there's a lot of backlog there. There are deposits there. So I think that some of that continues. Some of it is tied to infrastructure, so there could be some timing elements in our infrastructure there, I mean just actual construction. So there could be some timing elements that affect when that business actually happens. But I feel good about it sustaining. I don't know much overall, but I think it sustains. Certainly, memory is correcting meaningfully this year, so we expect it to do better. And I think on the legacy or the leading edge side, the competitive dynamics are pretty strong. The N3 node will be a long-life node, given the amount of design activity that's there today driven by multiple markets. The competitive dynamics are strong as well, which should play well to KLA being it'll help sort of enable and ramp that capacity. So I feel pretty good about all those factors in terms of how it's driving the setup into next year. How much? Not clear. But certainly, we're making decisions with an expectation that we'll see that. And if we don't, then we probably have more work to do from a size in the company for the current environment and the growth rate moving forward. But from where we sit today, that's how we see it.

Your -- you mentioned the Gartner 2022 market share statistics. And based on that, your #1 market share leadership in process control continues strong in 2022, right? You were 4.5x larger than your #2 competitor. Process control segment outgrew WFE by 20 percentage points last year. You outgrew that by 800 basis points, which drove, as you mentioned, 3 percentage points of share gain last year. And if I look under the hood, I mean you gained share in multiple areas within process control, optical inspection, bare wafer inspection, mask inspection, macro defect overlay, right, on top of maintaining your strong #1 share in thin film metrology. These are all the major segments within process control. What segments do you see share gains this year? And history has shown that there's been a pretty strong correlation, right, between your new product introductions and revenue growth, share gains. So help us understand what the team has in the new product pipeline over the next few years.

Well, and all that at 42% operating margins, too. We're pretty proud of at KLA in turn, and I think is reflective of the value that we believe we add to our customers and how we share that value with them. So I think one of the important aspects about our go-to-market at KLA is a portfolio of solutions that allows our customers to pick and choose across different technologies and capabilities and the economic drivers that affect their productivity. Most of our competitors are point product competitors. They don't introduce products as quickly as we do in terms of new capability, which keeps us a moving target. And when the industry starts to shift in terms of where it's inflecting the need for certain capabilities versus others, when you have the portfolio, you're much better positioned to be able to provide that versus going to the customer and saying, yes, this one solution meets all your needs. And it just -- given the amount of investment, given the returns that are at stake, that just isn't all that applicable. So when you look at the markets, I think most of the market share has come from the inflection around certain markets. And if you look at the last few years, in fact, the optical inspection, the pattern inspection business, which is effectively about 4 platforms across KLA, where we address that market, grew 1.5 -- actually 1.7x faster than overall WFE over the last few years, and probably one of the fastest-growing markets of scale in the overall industry. So our position in that market is very strong. And so as you see that market inflect and then the share we have, it tends to drive the overall market share results. Reticle inspection is another business to the company. It's a strong position. Again, a product where we address the market with a number of platforms that allow our customers to balance this technical and economic set of requirements. Also had a very strong above-market growth year. It's pretty close to doubling in the year. And so that was another one where, given what's happened in terms of complexity on EUV reticles, has driven -- so you have the complexity. But also then the volume, given the wafer starts and the design environment I talked about, is really good for overall mask. So there are 2 markets there on the metrology side. Thin film metrology had a share gain. And macro inspection for the first time, we're #1 in macro inspection as we start to see design rules start to shrink, and so the density of the lines and spaces are shrinking. And that plays to a higher capable solution, and so that's been a strong position for us as well. So a number of markets where we saw this inflection, I think that drove the overall share. Moving forward, a lot of investments across the company to continue to deliver capability to support high NA in an environment where you have pelletization and an increased number of reticles, and that's an important part of the second half of this decade. E-beam capabilities in review, but also inspection and metrology that we use to increase the relevance of the optical capabilities to point our inspectors. So I think that there's some new product offerings that are coming in those areas. We've used x-ray technology in some places. We're looking for a way to scale that more effectively to high-volume production. So a number of product opportunities, I think, that are coming down the pipe. We invest more than our competitors. It drives, a, this portfolio approach; but also the ability to introduce products at a quicker cadence. And big bets to ensure that we're well positioned in the future.

Yes. So let's talk about some of these product segments. Wafer inspection, you guys said on the call that you expect your high-end optical wafer inspection business to grow this year. This is a segment where you guys have 90% market share in a $3.5 billion market, right? These are your advanced Gen 4, Gen 5 broadband plasma inspection systems. These are the workhorse systems in high-volume manufacturing. We talked about new product pipeline as an indicator for business momentum. I know the team is working on their next-generation broadband light source. Does the team see optical inspection scalability well past the 2-nanometer node?